Favorable Inflation Reports

The two important inflation reports released this week were on balance weaker than expected. As a result, mortgage rates remained near the lowest levels of the year.

Another significant inflation indicator released this week, which measures costs for producers, came in far below the expected levels. The August core Producer Price Index (PPI) declined 0.1% from July, while the consensus forecast called for an increase of 0.3%. This followed a shockingly large increase of 0.9% last month, however, leading some economists to suggest that tariffs have increased the monthly volatility in this data. In any case, Core PPI was 2.8% higher than a year ago, down sharply from an annual rate of 3.7% last month, which was the highest level since March. Both CPI and PPI remain well above the 2.0% target level of the Fed. Of the two major inflation reports, investors tend to place less weight on PPI, since it reflects a smaller slice of the economy than CPI. Following the latest inflation data, investors now anticipate that the Fed will reduce the federal funds rate by 75 basis points over the remaining meetings this year.

On Thursday, the European Central Bank (ECB) held benchmark interest rates unchanged at 2.0%, down from a record high of 4.0% in the middle of 2023. This move was widely anticipated, and the reaction was minor. In its meeting statement, the ECB said that the outlook for inflation remains "more uncertain than usual" due to trade disputes, while the risks to economic growth are more balanced than at the last meeting. 

Lower rates were good news for mortgage applications this week, according to the Mortgage Bankers Association (MBA). Applications to refinance rose 12% from last week and were 34% higher than one year ago. Purchase applications increased 7% from the prior week and were up 23% from last year at this time, at the highest level since July.

Looking ahead, the next Fed meeting will take place on Wednesday. Most investors expect that the Fed will lower the federal funds rate by 25 basis points, but some anticipate a larger 50 basis point reduction. For economic reports, Retail Sales and Import Prices will be released on Tuesday. Since consumer spending accounts for over two-thirds of U.S. economic activity, the retail sales data is a key measure of the health of the economy. Housing Starts will come out on Wednesday.